Cabot (NYSE:CBT) Knows How To Allocate Capital Effectively

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at the ROCE trend of Cabot (NYSE:CBT) we really liked what we saw.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Cabot:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.20 = US$502m ÷ (US$3.6b - US$1.1b) (Based on the trailing twelve months to June 2022).

Therefore, Cabot has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

Our analysis indicates that CBT is potentially undervalued!

In the above chart we have measured Cabot's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cabot.

How Are Returns Trending?

Cabot has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 50% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

What We Can Learn From Cabot's ROCE

To bring it all together, Cabot has done well to increase the returns it's generating from its capital employed. Since the stock has only returned 30% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

If you want to know some of the risks facing Cabot we've found 3 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.